Chit Chat Stocks - LendingClub (LC) | Not So Deep Dive

Episode Date: January 18, 2022

LendingClub was founded as a marketplace designed to bring installment loans to the digital age. The company originally connected loan applicants with third-party banks. Fast forward to 2022, LendingClub has now acquired a digital bank called Radius Bancorp meaning they don't have to go through third-party banks. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of ZoomInfo. Enjoy the show! Our Tuesday Not So Deep Dives are sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "CCM" and get $10 off: https://7investing.com/subscribe/aff/4/ Interested in more of Brad’s work? Find his Substack: https://stockmarketnerd.substack.com/ Contact us: [e-mail] Timestamps Company Background | (3:05) Industry | (9:14) Management & Ownership | (11:11) Valuation | (14:24) Earnings | (16:54) Balance Sheet | (20:35) Our Analysis | (21:35) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome into Chit Chat Money. This is the Tuesday not-so-deep-dive episode where we cover an individual stock and go over the basics of a company in about 45 minutes or so. Hopefully,

by the end of this episode, you understand this company well. And we're talking Lending Club. It is, well, it was a hot IPO about five years ago, and it was kind of a tough story. We'll get into the history eight years ago now, I guess, more than five years ago. Stock was down almost 90, over 95%, has since recovered. They've transitioned their business model. We'll get into all that stuff. But Brad, this was your choice today. Why did you pick it?

And did you know about Lending Club beforehand? Yeah, I learned about Lending Club through researching Upstart and just, I mean, as a big fan of Upstart and what they're doing, I wanted just to learn more about this similar but different, same but different approach that LendingClub takes. And we'll get into a little bit why they're different. But just, I mean, the bank partner route versus the bank charter route is the real line in the sand. And I wanted to learn more about how that's serving them. Yep. They're a lender, as Brad is alluding to there. I'm going to let Ryan introduce the company, but first let's talk about our presenting sponsor for the Not So Deep Dive episode,

Potential Multibaggers. They've been our sponsor for a long time and you know that they provide a quality service. The aim of Potential Multibaggers is to find stocks that can go up 10X over the next 10 years or compound at 26% per year. Now, these are high growth stocks. They're going to have lots of volatility, but the aim is to hold them for a long period of time. Of course, they have to continually perform and do well. The businesses have to continue to grow their financials, grow their revenue, grow their cashflow, all that good stuff. And Chris, who we've had on the show before and his team behind potential multibayers, they call this buy and verify. So when they make their picks, they're not just making it and letting you go out on your own and then seeing if a stock goes

down 50%, you have no idea why. They are with you writing about stuff, doing updates constantly. I get their emails. They're doing multiple emails per week, analyzing these companies. So if you want to partner with some high growth investments, they're a great team to go along with it. And if you want to sign up for potential multibayers and become a multi, you can go to Seeking Alpha and look for From Growth Through Value. Google it or go to at From Value on Twitter. All right, Ryan, do you want to introduce Lending Club? Yes. So Lending Club, not to be confused with LendingTree. I made that mistake, wasted a few hours of research, but don't worry about that. LendingClub was founded as a marketplace designed to bring installment loans.

And most people probably know what installment loans are, but it's basically just a loan where you get a set amount all at once and then pay it back over scheduled payment dates. So they were trying to bring installment loans to the digital age. And so people looking for loans to help, say, pay off their credit card debt. Their credit card refinances is a popular product for them. People trying to pay off their credit card debt would come to Lending Club. They'd input a bunch of information and Lending Club would process the data, determine their credit worthiness, and then connect them with a loan offer from a third-party bank. And so that third-party bank, and there may have been multiple, then defer the risk by selling the loans to loan investors.

And so that part, like a lot of banking products, is probably a little more complicated than it sounds. They might do different bundling packages, have different risk, I guess, tranches depending on the type of investor. But those loan investors basically include other banks, asset managers, insurance companies, hedge funds, some probably high net worth individuals, anyone that's trying to get. And if you're wondering why would there be those loan investors, a lot of these are, say, personal loans that are high interest. And so you could get 10%, 12% on a personal loan, let's say. And as a loan investor, that's pretty attractive. So that's basically what brings them in. And then Lending Club would receive money from that third-party bank basically for referrals.

And this was known as transaction revenue. And that, for a long time, was their primary source of revenue. Anyway, fast forward to 2022, LendingClub has now acquired a digital bank called Radius Bank Corp. So now LendingClub no longer needs to go through third-party banks. Instead, LendingClub can either sell the loans to loan investors themselves, or they can fund the loans with their own balance sheet. And so it's a very different business. And these loans include personal loans up to $40,000, business loans, auto refinances, patient solutions was another one of their products. And I think this is like dentists or doctors can use Lending Club to help their patients finance the basically visits.

And those are, that's kind of the holistic view of the business. Does that all make sense to my blanket on anything? It's a bank. It basically is a bank now. but they still have a transaction fees, right? They have a bank plus another business. Yeah. So they are still, I guess banks sell loans anyways, too. So yeah, it's a bank at this point and I'll get into the history though.

Lending club was initially launched on Facebook in 2006 as one of Facebook's first applications. Kind of interesting there. Wonder what it would be if it was still on there. I don't know everything that launches like that everything that launches on Facebook or like Amazon and there's always a partner it's almost feels like they're a virus and eventually Facebook takes all your profits so I feel like that's what happened you know I feel yeah yeah in this case they were able to get off Facebook pretty quick so in 2007 Lending Club received a 10 million dollar series a round and then turned into a full-scale independent peer-to-peer lending

platform they call it peer-to-peer but i i take some hesitance with that term because it's really like uh institution to peer in this case because it's it's big investors typically right not pure not a real pure play peer-to-peer if you want to describe it like that yeah anyway the um they grew it's not vamo it's not vamo and if they're not you're not like we're not like an individual buying the loans. That would be peer-to-peer. I think you have to be, I'm guessing, an accredited investor. Yeah, probably. To buy these. But that's not that important. And I guess it grew pretty fast pre-IPO, but they did face a lot of regulatory headwinds. And that's kind of been a theme throughout their entire history. And maybe it's just that they are kind of peer-to-peer

lending was kind of like a new concept, I guess, or bringing installment loans to the digital age maybe faced a lot of hurdles. But they IPO'd in 2014. And then in 2016, they ran into a lot of trouble. So based on a Wikipedia article about LendingClub, it says in April 2016, a LendingClub employee reported Laplanch, or I'm sorry if I'm butchering that name, Laplanch was the CEO at the time, that the dates on approximately $3 million, $3 million U.S. dollars in the firm's loans appeared to have been altered. Lending Club then hired an internal auditor to investigate the issue and it was reported that this investigation found additional problems with loans, including that $22 million in loans which had been sold to Jeffries Investment Bank did not in fact meet

the bank's investment criteria. Lending Club bought these loans back from the bank and resold them. So following the issue, the board of directors basically asked Laplange to step down and he did. Lending club stock at one point was down more than 95% from its post IPO highs. It's still down substantially from its post IPO highs, but it looks like they've turned things around a bit. And I believe most of the regulatory problems are now in the rear view. They settled with the FTC in 2021. So that should be behind them, at least that case, but there's still some lawsuits I saw in the 10Q. If you're really interested in this company, I'd probably research that. But other than that, I mean, they could have some regulatory issues. But now,

since they're a bank, it's going to be more structured. So they're not going to have the chance to mess up for that long, since as a bank, you have the people following you constantly. All right. Industry and competition, pretty simple. They estimated, and this was just management at an investment conference, that their market opportunity was $120 billion in 2019. that has come down recently because the demand for these types of products has decreased because of the COVID dynamics and the stimulus and all that stuff in the United States. There's a ton of variables, but the long story short, the demand for loans like this has, the market's gone down a bit. But for reference right now, they're doing approximately $1 billion in originations a month.

So they have pretty decent market share of their existing market opportunity. However, as we'll talk about later, they're going to continue to try to lend and do more products. So I think their market opportunity will grow. $120 billion is not the entire lending market in the United States. So hopefully that'll grow over time. Competitors, pretty easy to identify, but there are a ton of them. So banks are a competitor, a lot of fintechs out there. Some individual ones I think I would highlight would be Square. They're doing individual loans on the Cash App now, SoFi, and Upstart. If you want to listen to our show on Upstart and the interview we did with Chris from Potential Multibaggers,

Upstart is a bit different, but they're still kind of competing with Lending Club, except they're not a lender. Our not-so-deep dive from like a year ago now. Exactly. Yep. Yep. Yep. I think that was the first time we all looked at the business. Yeah. So, competitors, though. Sorry? My inspiration for owning Upstart, that was the episode. That's right.

Got to be your favorite episode from last year then, right? Oh, yeah. Made you a bit of money there. Basically, anyone that is any company that's lending to people, that's going to be a competitor because the whole goal for Lending Club is to increase the volume of loans on their platform and have a good loss ratio, if that's the correct term. I don't know all the banking terms, but not have them all be bad loans. All right.

let's move to management and ownership. Brad, do you want to talk about the team over at Lending Club? Yep. So current CEO is Scott Sanborn. He's been the CEO since 2016, which I think if Ryan or I'm looking at the dates. So around the time of that regulatory fog, he kind of took over. He's been also the COO since 2019 when Samir Gulati, who was the COO from 2016 to 2019 left to work on some other fintech startups. And it looks like he's also the chief marketing officer. So he has, and this is according to the website, three executive roles with the company as of right now that all say present. So good for him, busy being. Real renaissance, man. Yeah, absolutely. He was the chief revenue officer and chief marketing officer at a company called eHealth

Insurance. And he's got a 77% Glassdoor approval rating. So pretty good, not amazing, but it has over 700 reviews. So that's a pretty sizable sample size or sizable sample size. But yeah, you can take it with pretty seriously, I think. So CFO is Tom Casey. He's been the CFO since 2016. He's got an incredible resume. He's been the CFO at JP Morgan and Citibank. He was at JP Morgan in that role for six years. He's also been the CFO of GE Capital for a decade. So really impressive resume. Good to have him on the executive team, I think for sure. The chief administrative officer is Brandon Pace. He was a former vice president and general counsel at eBay. He worked for a bunch of law firms that I didn't recognize before that. And then chief capital officer is the other person

that I'll highlight. It's Valerie Kay. She climbed the ladder at Lending Club and spent before then 12 years as a managing director at Morgan Stanley. So definitely some relevant experience. In terms of ownership, this is one of the first proxy statements I've ever seen that didn't actually give us ownership data, but third-party sources all had very similar measurements of insider ownership, so I think that's a pretty solid indication. But Sanborn outright only owns about $28 million in stock. He does make $6 million a year, so don't feel bad about him. And there also are some restricted stock units outstanding that Brett's going to talk about in a little bit. Um, so, and then institutional ownerships at roughly 80% of the float with total insider ownership.

So the executive team, board of directors, all that at just 2% of the float, um, which is not, not super uncommon. I'm considering there, there've been some changes in leadership, uh, that, that generally correlates pretty heavily to lower insider ownership because founders like to pay themselves a lot in stock early on. Uh, but yeah, that, that's, that's how ownership shakes out and we'll move on to valuation now. Well, I think the reason he makes a $6 million salary is because the COO gets paid $2 million.

The CMO gets paid $2 million, and so does the CEO. Right, right, right. $2 million per job title. So he definitely earns every penny. Yeah. Yeah, it's a pretty high salary, but it's not egregious or anything like that. Seems, I mean, it's high, but it's not like, oh, man, this guy's just totally stealing all the money that could be promised. but I'll evaluation, uh, I should reference market cap was only $400 million in October of

2020. So it has been, it was totally in the dumps. Um, current market cap is $2.5 billion. Uh, so it's, it's really had a strong recovery here. Obviously it's still, you know, since it was down 95% plus from its IPO, it's still down a ton from its IPO, but as you can see, and we'll get into the business has recovered quite a bit. Ticker is LC. Um, so I think PE metric is probably the best one to use for this company. I usually do not like to use P-E metric, which is price to earnings, if anyone that doesn't know. And we like to focus on cashflow, but since this is a bank, I think earnings is a much better indicator of how they're doing. However, since COVID, they've had a total, their originations are down a bit and they're only slightly recovering from

that. So it says their PE is like 300, if you look at it. But the last quarter, they did what, like 20 something million in net income, something like that. So I would use PE here. But right now, the current one doesn't look that hot. I would look at the current quarter. It's really hard to put multiples on this thing. I mean, you look at the interest income margins, all that stuff. Brad, do you have something to add there? Yeah, just in Coifin, if anyone's familiar with the service, I'll give it a free shout out in promotion, but it has them at like 15.15 times 2022 earnings and then like 11 times 2023. So as Brett's kind of saying, they're inflecting to positive net income right now and the PE is reflecting that and will rapidly come down. Right. The analysts who follow the company definitely think that this will continue and that their PE versus whatever their 2022 estimates is pretty low, but trailing, it's going to look really inflated. Price to gross profit, which I guess can be a decent one, is 4.2, so pretty low.

Only other thing I'd mention is they have 11 million RSUs and 5.4 million granted through the first nine months of 2021 versus shares outstanding of 100 million. So if they're granting 5 million RSUs a year, I don't know if this is going to be every year, but if they're granting 5 million RSUs a year, that'll be a 5% dilution rate. So that's pretty impactful for this business. Other than that, I mean, they have a return on equity of 14% right now, which is pretty impressive, but they used to be, this is like their only quarter that's ever been positive. So it's hard to tell if this is a one-time thing. All right, Ryan, do you want to hit earnings? Yeah. And I'll start with the full year guidance that they gave and then kind of moved to the most recent quarter. I'll also, I know

Brett kind of alluded to this, but their earnings are bank earnings. So it's a little, it's difficult or it's different than reading a typical, say, SaaS company. The financial statements don't look quite that, quite alike. So the first, for, I guess, the fiscal year of 2021, Lending Club expects to generate $796 to $806 million in revenue. That's a 153% increase from 2020, but roughly a 5% increase from 2019. So in 2020, they saw a 71% decline in transaction fee revenue. I don't know if that was them weaning off the third-party banks or purely just a decline in originations. That's it. Yeah. It's just a decline in originations. So even if the originations. no no they are always originating but then after funding them yeah after they weren't originating

until they were a bank they started originating but they couldn't originate until they were a bank okay i'm using i'm using this term wrong but they get the transaction fees like that's what ryan's referring to here so they they reported originations in 2019 which was prior to them having radius bank corp so i think originations they're using the term differently than then you're thinking is it's like yeah yeah sourcing sourcing is a better term yeah um but anyway so 2020 was i guess just a terrible year for them um but this year they're expecting just over 10 billion dollars in loan originations for the year that's a double from 2019 or 2020 and it's a little less than 2019 but it's a different those originations

have different economics now because a lot of that is funded by themselves. So the revenue mix looks different today. So for reference in the third quarter, Lending Club had $181 million in non-interest revenue. So that's the referral or transaction revenue, but had 65 million in net interest revenue. They actually report it as net interest income, but it's pretty much just revenue. And so that's a 76% to 24% split. Last year, only had 18 coming from interest revenue so i believe their net interest income is up like i want to say 300 percent um i should probably have that number handy but i don't um and so they're seeing a lot of growth in that they're starting to fund a lot more of these loans

themselves and a lot of different products themselves i guess because it's not all like personal loans um and then their earnings before taxes was 30 million dollars for the quarter. So that's about a 12% EBT margin. And then net income margin was about 11%. So they are starting to see that inflection upwards in their earnings. What earnings margins do they have at scale? I'm not really sure. I guess you could probably just compare to other digital banks because it's probably not all that different. But yeah, profitable business should be a profitable business, but it's certainly a different one than it used to be. I think, and they talk about being their own bank, they're able to pull out a lot of the costs and that they're going to be

more profitable as their own bank. So yeah, hopefully that will continue. They did mention that about their goal is for in between 15% and 25% of all new loans that are originated to end up on their balance sheet, but before they sold all of them off to third parties. All right, Brad, do you want to hit balance sheet and liquidity? Yeah, it's actually, it's pretty, it's in pretty good shape. So $862 million in cash and equivalents. They have another $340 million in restricted cash and marketable securities. They have just $15 million in long-term debt and then another $2.5 million in interest

bearing deposits, another $46 million in short-term borrowings, and then $300 million in retail notes. So just quick math, like $350, $360 million in debt liabilities on the balance sheet. and it looks like interest expense was around 7% of revenue in the last quarter. So not that low, to be honest, but the balance sheet's not in any kind of stressed shape from what I can tell. Yeah. And you did say 2.6 million, but it's 2.6 billion in interest-bearing deposits. Yeah. 2.6 billion in interest-bearing deposits. Thank you very much for that. Yeah. That's the big part of the balance sheet is they have the assets and liabilities of the

thanks. All right, let's hit the ad break. And we're going to talk more about our opinions, analysis, what we like and dislike about LendingClub's business. This episode is brought to you by La Quinta by Wyndham. Here you are miles from home and ready to start your vacation. Good thing you're staying at La Quinta by Wyndham. They have free high speed Wi-Fi to stream all your favorite movies. And in the morning, get fresh waffles with their free bright side breakfast or squeeze in a workout at their fitness center either way you're ready to conquer the day tonight la quinta tomorrow you triumph book your stay at lq.com this episode is brought to you by kpmg as a business leader how can you innovate build trust and move forward in

a digital era kpmg can help by bringing together the right talent and technologies generating insights that spark opportunities. To explore their thinking, visit reed.kpmg.us slash opportunities. Okay, welcome back. Next up, we have anecdotal evidence. I don't think any of us have used, well, maybe Brad didn't write anything down, have used the product. What are your thoughts on it, I guess? Nothing. I did, I guess I filled out an application and it was pretty easy um so that there's my anecdotal evidence all right ryan yeah i i did the same thing as brad just to take a look at it um and for some reason i like don't like giving up my data i don't know why i have that sort of caution but uh so i put in like a fake name

and oh yeah it's not out there don't worry no one has it like we can't find you so they they they acquire a lot of data, I believe, from a third party. It's very unique. Yeah. But no, I've never applied for a personal loan. I don't see why, and we're going to get to this. I don't see why I wouldn't just price shop across all the platforms just to see who could give me the cheapest loan. I'm certainly not loyal to a single one or would I be? Yeah. All right. I'll hit mine. Yeah. Same thing for me. I mean, my only thought anecdotally is that, okay, if I'm a person that is going to need a loan like this, uh, fortunately I'm not, but if I was, I would have no urge to choose them over someone else. And that's comparing it to say another, a lot of other product categories, you definitely have brand loyalty. And I feel like with this one, there's less of it. It's more of just, okay, I'm going to shop around. And if the person I'm been using before, which maybe can help lending club because they

have the established base, if the person I'm using before has close to the best rate, I'm probably going to use them because I have an established relationship. All right. Future growth opportunities, Brad, what do you got for us? Yeah. So the payday loan market rightfully gets a terrible reputation. And it's because it's predatory in a lot of ways. But I think there's so much room to fix it. And there's still so much need for people to take out loans of a couple hundred dollars, not just a couple thousand dollars. And that need won't really go away. So if a company and Upstart's actively trying to do this, and I think Lending Club should be as well, if they have an underwriting model that's capable of identifying what people call this hidden prime,

what a FICO score credit model isn't capable of determining is a prime borrower, but truly is a prime borrower based on alternative data. If they're capable of doing that, then you can turn what's two, 300% APRs that people are, or annual percent rates, I'm sorry, APR annual percent rate that people are paying to take out four or $500. And Upstart is going to try and do it for 36% or less, which I know, holy crap, 36% is a really tough pill to swallow, but it's a lot less tough than 200%, 300%. I think doing this better is a really big opportunity for a lot of institutions and a lot of banks and a lot of fintechs like Upstart. I should say it'll also inevitably invite more regulatory attention and scrutiny because this form of lending has such a rightfully

deserve terrible reputation. Sorry. Yeah. And I think Lending Club has that same 36% figure. So I think a lot of these platforms are trying to, I guess, displace the old way. My future growth opportunity, and this isn't a very novel one, but it's just funding loan originations. They obviously have the bank business, or I guess they have a bank charter now. But utilizing them as a bank to earn interest income really feels like what's going to happen for this business moving forward. And it doesn't have to all just be personal loans either. There are a lot of other areas where they can earn interest income. So some of the ones they highlight on their earnings report is residential mortgages, equipment financing, commercial real estate.

These are all part of their current loans and leases that are held for investment. I guess the opportunities to earn interest are kind of endless. So I guess wherever they can do it, especially now that they have the bank charter, that's what they should be doing. All in mind, it's auto loans. They're getting into auto loan refinancing for their 3.8 million members. This is a large and well, I don't know if it's lucrative, but it's a large and I think pretty profitable market. And when they can put these loans on their balance sheet, like Ryan was describing, that can be a lot better for this business specifically. So for reference, management was talking about this.

They say a loan on their balance sheet earns three times as much compared to just an origination. So to describe this again, because it's the most important part, previously, they would source the loan in their marketplace and then sell it to someone else. Now they source it and own it as an investment, quote unquote, on their balance sheet, like a traditional bank. That was a bad risk. And they take the risk along with it. So when they would just originate, which, and then sell it to someone else, they said on average, they would earn $4 for every $1,000 that they would originate. But now under this new model, they earn $12 for every $1,000 they originate, which can, before their model was really not that profitable. Now it can actually be profitable and they can self-finance this.

They described it as a flywheel, but they're just describing a banking business model. So it's like, still, it's a good business model and it's a lot more profitable. Don't know if I'd call it a flywheel, but yeah, that's my future growth opportunity. Let's hit highlights and lowlights. Brad, what do you like and dislike about this business? No, it's the flyest wheel for sure. But for highlights, I think it's blatantly obvious that FICO scorers need a makeover and an upgrade and an evolution in products like this that leverage or try to leverage and say they

are. Modern data science can do that. I think there's a lot more information that's needed on borrowers to uncover the true risk of a borrower that FICO Plus models that most banks are using just can't do. So there's a lot of value to create there for companies that are able to underwrite more effectively and to offer lower rates and to raise approval rates without impacting loss ratios, you can, overnight, you can create a larger loan book without taking on more risk. If you can do this acceptably, if you can do this effectively over long periods of time, which kind of leads into the low light of, which is not specific to LendingClub, but it's specific to that sector, including Upstart I own and I'm excited about, of how much of this impairment

rate outperformance, how much of this loss ratio outperformance is powered by stimulus checks being put in people's pockets and how much of this demand is being driven by the macro backdrop being pretty darn favorable for personal loans at the moment, considering how cyclical the loan industry is. So how sustainable was that incredible 2021 that both of these companies just had? And I think we're going to learn a lot about that in 2022. So yeah, low light is how much of the success was unique to them and how much of the success was unique to their environment. That's a good point too. Interest rates, all-time low, that helps with lending too. Ryan, what's your highlights and lowlights? Well, let me also mention that, Brad, you talked

about them displacing the FICO score, but here's a part of their 10K. It says, borrowers applying for loans through our programs must meet certain requirements or certain minimum credit requirements, including a minimum FICO score. They're just, so they're using the FICO score. Yeah. Upstart is, Brad, you know it more than me, but Upstart. Upstart's eliminated all FICO minimums when they're actually originating a bank. Bank partners can specify FICO minimums. And then a lot of them have been eliminating that as they become more confident in the model. So that's a good thing to point out, Ryan. I just think there's a lot more information needed to finish painting the picture of risk that FICO doesn't address and

collecting more data and correlating that data effectively can create a lot of value. Right. It sounds like Upstart is confident to just not include it at all, but Lending Club is kind of still wants to attach a bit to the old model and then add stuff on top of it. They use it as a variable, but it's just one of many, many variables that they use. Right. My highlights, I think the radius acquisition just makes Lending Club a better business, a more attractive business. Obviously, it allows them to fund the loans themselves. It also gives them a cheaper funding source. They highlighted this. Consumer deposits instead of third-party warehouse funding. But if they're spending a ton on sales and marketing in order

to attract customer deposits, the cost might still be expensive in order to get that money in. But either way, I still think Lending Club looks like a much better business with Radius in there. They also have some experience on their side, which I think should give them, I guess, years of data to help them enhance their credit determinations. So if they have sort of decades worth of experience in seeing borrowers, they know where they've made mistakes and hopefully they're learning from that. and it should be quote-unquote enhancing their models or um or i guess they're do they use the term ai in there or is it machine learning i don't know just i yeah i don't know i for upstart every paragraph uh low lights for me i don't see a single competitive advantage in they're just a bank yeah but and they're also not so the competitive advantage of an existing like

bank of america chase wells fargo whatever is switching cost i think i don't know yeah um for a personal i don't think lending club could have that but i think it's not as strong just because you're not attached to them basically for all your personal finances yeah and i was looking at radius because that's obviously an important part of the business now that they're going to get a lot of their money through consumer deposits. And it doesn't, there's nothing that excites me about it versus in terms of a digital bank. There's nothing that for me says this is going to be, this is going to grow market share among digital banks versus say an ally or something like that. Right. So that's, that, that to me, I guess it just seemed like it lacked competitive

advantages. Yeah. All right. Highlights for me, I like the bank acquisition. I think we're all in agreement with that. It fixed the unit economics. Their FTC issue was settled, although there's still kind of an overhang there. And I don't think it's mainly from the FTC, but I think maybe there's a consumer overhang where people don't think Lending Club is a reputable place. And that's very important. I don't know. They still have 3.8 million members, but there could be some people that don't like them because they heard about the story. highlight for me is rapidly growing ROE, which is return on equity. And that is the most important metric for a bank. And I guess to do a little lesson, because I think a lot, we never really

talk about ROE, probably because we don't talk about banks that much, but the average return equity for the banking industry in say the third quarter of 2021 was 5.3%. In 2020 was 5.3%. The average roe in the third quarter of 2021 was 14 so lending club is really right on par with everyone there and it measures the amount of company's income that is returned as shareholders equity so it's just the return on equity that's what it is um so for anyone that doesn't know i know a lot of people when you're you're learning about this um that can seem like a mystery what return on equity is all right let's get back to anything else i had uh let's see i mean the i guess they have an asset light model that gives them some sort of an advantage versus traditional lenders

they said that gives them a cost advantage but over time i think that'll disappear as all bank branches go away like just like first traditional banks yeah exactly who are really some of their largest competitors now a lot of their other competitors are still the same asset light and over time that should all go to zero well that's for me ftc overhang heavy dilution is coming and And it seems like if it's going to be a 4% to 5% rate, that is a big headwind. And I'm not confident in their competitive advantage or any sort of reason why people go to them five years from now, which is kind of the big concern for me, the durability of this business versus competitors like Upstart, SoFi, you name it.

But that's really it. All right. Bold case, Brad, what's your bold case for this business? Yeah. So bold case is this 150% growth and improving unit economics that they had wasn't just recouping pent up demand and wasn't just recovering from a pandemic and wasn't macro driven, but is instead just the start of something, something big. So again, looking at Koi Fin, they're, they're expecting above 20% growth for the next three years. So that, I mean, yeah, that versus

5% growth over 2019, I mean, that would be a pretty large step up when we're comparing similar macro backdrops. So that if that happened, that would be great for them, I think. And if they can continue to compound at a lofty rate with the multiples that they're currently sporting. And I know we shouldn't talk about valuation, but there's something here if the business is defensible and durable and sustainable, which bull case is that yes, it is. Yep. I agree. Ryan, what's yours? Yeah. My bull case is that they're able to be a high quality bank. They're able to grow customer deposits at sort of a double digit rate for the next several years for reference.

and I'm not sure how much of this was due to maybe the environment that they're in, but deposits grew 12% sequentially, so quarter over quarter to $2.8 billion in the third quarter. That's really going to drive, I mean, customer deposits are going to drive growth for them because that's lendable assets right there. And they're able to earn interest income on that. That's for me, the bull case is that the lending club is a good bank. Yeah, I'm going to be even more optimistic because I don't even think they need to grow origination volume to make this a good investment given their valuation. I just think you need to have it stay stable, loss ratio stay low, and then turning into the full banking operation for

a couple of different years, two to three years, something like that. Get that fully operational. I think if that happens, if volume's the same and 20% of it is on their balance sheet, they'll do fine. You add on rising interest rates, which there's a net positive. I think now it's tougher to lend, but they'll get much more net interest income, which has soared since 2020. I think that, and then if you grow, actually grow origination volume, I think it would be a fantastic investment. The big thing is, and I think we'll get to this with our bear case, you know, how confident are we that that's actually going to happen? So Brad, what's your bear case are you sure rising rates is a good thing for them i feel like that's probably bad

well it's good for net interest income i mean it's harder for lending though for them it's 36 percent's the cap right now they can't do that no i'm talking so when you're lending out so when you're lending out it's harder because you know your cost of capital is harder for a bank but when you have the assets on your balance sheet you'll earn a higher rate on that because your net interest income will be higher. Demand headwind, profit tailwind. Yeah. I think it'd even out to be fine. So I guess it's like, I don't know, it could be a net negative, but I think it'd probably be a net positive just because they're a bank now. All right, Brad, do you want to hit bear case? Yeah. I think I'll go with the minority argument

here, which is I don't love the path of becoming a bank. So I really, I mean, banks, banking is extremely commoditized, extremely competitive, and extremely regulatory intensive. I know I'm not saying that right, but oh, well. And I think the path of choosing to partner with banks and to be kind of the data science arm and to plug into bank ecosystems that have access to all this data because they have millions of members, I think is just a way easier path to success. And I don't think that the path that Lending Club is taking is the correct one. And I reserve the right to be wrong, as people say so often, but the bare case is that I'm not wrong, that becoming the asset-light fintech that uplifts and augments banks is a more lucrative path than trying to

do the traditional banking. Right. That, I think, is a big concern, that banking itself is just a commodity and that you don't have the established They're not a giant one that it'll be tough for them in that regard. All right, Ryan, what's your bear case? I think a lot of what Brad just said is probably comes into my bear case as well. The other one, and I think there's a few bear cases that could play out. First off is that there's another 2016 like scenario that occurs and that there's something fishy going on under the hood with maybe some of their loans.

And then second is that they don't have a competitive data advantage that they say they do and that consumers are really just looking for the lowest possible rate. And then on the other side, not only on the lending side, but on the digital or on the customer deposit side, there isn't the differentiation. Like if they are the same and it is sort of a commoditized industry and people are just looking for the highest yield in their checking account or their savings account, that's a hard, that's a really competitive market. Yep. Yep. I think, yeah, it's not a good way to describe it. My bear case is that the ROE and profitability bump that they had the last quarter, it was really last quarter, a little bit, it's two quarters ago. that was just a one-time thing. It looks like it probably isn't, but it's hard to tell. I mean, their track record over the last five years is not strong. Yeah, they had COVID. Yeah, they were absorbing the bank. Yeah, they really had those problems with the FTC and stuff.

So maybe it's permanent. Maybe ROE will be higher over time. And then on top of that, if origination volume dries up as they start losing to competitors, that would kill. I mean, it would just make the business a lot smaller. The whole key here is origination volume, good loss ratios, and growing the balance sheet. If that happens, that's good. If it doesn't happen, the investment is going to be bad. All right. More or less interested, Brad, what are your final thoughts here? Yeah. I really, really thought I was going to be more interested at the end of the episode, but I think less interested. And I just, it's because I agree that there's nothing really defensible here.

And I think how you create a defensible product within this very mature and established lending market is with data science and is with AI and ML models that I think banks need in order to do things better and banks need an ability to collect and aggregate and make sense of a lot more data than they currently do. And I think that's where you create the value and that's where you differentiate yourself. and I don't think that's right. And I know that's not where Lending Club is going. So that's kind of what I wanted to see from them and wasn't really what I saw. So hopefully I'm wrong. A lot of smart people love Lending Club and there are reasons to really like it. But for me at this

point in time, less interested. Yeah, I think I can speak for all three of us here. One of the big concerns is analyzing a bank is not our forte. So I would be kind of worried about missing some stuff. I don't know if Brad, if you're in the same boat there. Yeah. I mean, the financial statements between Upstart and LendingClub are a lot different than you might think they would be. And that's just because Upstart's a software company and LendingClub is a bank. So yeah, it really does add a layer of complexity that you have to really take your time to grasp if you want to be invested. Exactly. Brian, what are your final thoughts? I'm less interested. there's a lot of uncertainties for me with LendingClub or especially like sort of macro

uncertainties. I'm not sure how much of the performance lately is temporary versus sustainable. And then on top of that, I don't know how the digital banking landscape is going to play out, which is obviously a huge part of their business now. So just all in all, less interested. Yeah. I'm going to be less interested. I have trouble understanding banks, So it kind of makes it put it in the too hard pile already. I think if I did, it seems like a compelling valuation. If you could really dive down, you're kind of like, well, no one's like Buffett with banks, but if you understand it to a level where you can kind of tell who's better than another, which I can't, then maybe this could be an opportunity. But again, that's why

I'm less interested. Also, I feel like the predictability of who's going to want to go to what institution, whether it be Lending Club, traditional banks, Upstart itself, which I guess they do more of the, they're not doing it themselves, but SoFi, OpFi, gosh, there's other ones out there. There's so many. I think the predictability of where Lending Club will be at in 2025, their origination volume, I have trouble having any confidence in a prediction there. So that's why I'm less interested. Brad, you have something to add? Yeah, just one more thing for the listeners. If you're invested in Upstart or SoFi or Lending Club or any other financial institution, all of them are going to say, we do better at this,

this, this, and this. But there's free information out there where you can vet what they're saying. So the Kroll Bond Rating Agency and Morningstar DVRA, they both have free surveillance reports that you can go into and look at these securitization transactions and see how loss ratios are actually outperforming. So you don't have to rely on a CEO with every incentive to talk up their own book to actually understand that they're doing better. So I would just really lean heavily on those data sources if you're going to invest in any of these. Right. That is a great point. All these management teams do talk up their lending standards. All right. Stock for next week. It was my choice. And I did a poll on the Chitchat Money account.

If you want to participate in these or give us any suggestions, follow us. Just search chitchat money on twitter you'll be able to find it or email us or email us it's in every show notes we get some of those there too um the choice was uh by the listeners was axon enterprise this is one brad have you heard of it before i know they they have tasers they they make tasers they are the company that makes the taser and they do a lot more now so it'll be fun to do that one kind a big software business episode yeah should be fun yeah the uh all right ryan anything else before we wrap up no uh feel free to leave us a rating on spotify or apple if you want uh we appreciate that helps the show grow uh and spotify one literally takes two seconds you don't even

there's no comment or anything like that you just one or five stars whichever one you want Yeah, it can take less than five stars. Say five stars, like Brad said. Don't do one star. All right. That's going to do it for this episode. Thank you all for listening. Remember, we are not financial advisors. Anything we say on this show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time. you